Demand Composition Inflation
TIle last of the structural theories of inflation is what is known as ‘demand-composition theory’ recently propounded by Professor Charles L. Schultze. According to Schultze, neither cost-push nor demandpulltheories can offer an adequate explanation of inflation. He points out IIIat prices and wages arc comparatively insensitive to decrease in demand, but they respond rather quickly to increase in demand. In other words, if demand decreases prices and wages do not go down quickly, but if demand increases the illcrease in price ami wages is almost simultaucous. Schultze thinks that it is a rapio shift in the composition of demand which will lead to a general price rise, even though there may have beenno increase in the overall aggregate demand or a general increase in the level of wages. A change
in the composition vf demand means , for in lance,that there is an increase in the demand for the product of one particular industry, whereas there is a similar decrease in demand for the product of another industry; hence total demand remains the same; only its composition has changed The prices of the products of that industry will not change much whose demand has decreased because prices arc relatively insensiuve to decrease.
in demand. On the other hand, prir-v, of the products of that industry will go up whose demand has mcrcascd because prices are relatively senvitive to increase in demand. I hus, according to the demand-composition theory, it is a change in the composition of the demand, as explained above, which is responsible for inflation and not either increase in aggregate demand or a cost-push in wages. The inflationary situation of 1955-57 period seems tv conform reasonably well to the demand-composition theory. The policy implication of this theory is that because
inflation docs not arise from age aggregate excess demand hut largely from excess demand in particular sectors of economy, prices cannot be controlled by general monetary and miscalculates. Hence what is required is the adoption of selective controls or selective monetary and fiscal policies. In India, ill recent years, the Reserve Bank of India has made an cxten i cue of selective credit controls to combat
intl anon ry trends. Schultze’ theory gets support from many can onists now, Of cour e, there can be pure-demand pull mll auon when good: arc in short supply and demand is exce I e l1: in the post-war II period. But demand-pull inflation docs not explain w hy prices rise faster than II crease III demand or increase in wages, Schultze’ t ry prcct ely explains this. He has explained why there can be inflation In the absence(; demand-pull co t push forces.
aggregate demand exceeds aggregate supply at the full employment level, inflation is inevitable. This is the demand-pull theory. Between three two extremes of demand-pull and cost-push theories lie a number of structural theories which attribute inflation to structural maladjustment in an economy, Among the structural
theories, we have mentioned the demand-composition theory of Schultze which a’s That a. in the composition of demand will create an inflationary situation even the ab (If either excess of aggregate demand or autonomous cases.